Seeing the forest for the trees

Corporate governance in China is lousy

CAN you trust Chinese accounts? Many investors fear (and several short-sellers are betting) that the answer is “no”. Sino-Forest, a big forestry firm listed in Toronto, is a case in point. Last year Muddy Waters, a short-seller, accused it of running a Ponzi scheme, which it denies. On January 31st Sino-Forest released the final report of independent investigators into the charge. Insiders crow that the gumshoes found no smoking gun. The gumshoes grumbled that, lacking access to all the evidence, they were “not able to reach definitive conclusions”.

America's SEC is trying to force the Shanghai office of Deloitte Touche Tohmatsu, a big Western accountancy firm, to hand over papers related to Longtop, a Chinese software firm that was delisted by the New York Stock Exchange last year. Deloitte refuses, saying this would violate Chinese laws on “state secrets”. Deloitte may have a point. If it co-operates, its local staff could be jailed under Chinese law.

Many accountancy problems spring from reverse takeovers, when a Chinese firm buys a foreign one to acquire its listing. T. J. Wong of the Chinese University of Hong Kong has analysed 200 Chinese reverse takeovers in the West, and found that many have run into trouble. The troubled outfits are typically smallish private ones that opted for a backdoor Western listing because they could not list in Hong Kong (where reverse takeovers are barred).

Western accountancy firms have taken flak for lending their good names to dodgy Chinese firms. But the international boss of a Big Four accountancy firm says this is unfair. The first 156 Chinese reverse takeovers were not audited by Western accountants, he says, but by their Chinese rivals. He insists the Big Four have greatly increased their vigilance in China.

Michael Thompson of the China Europe International Business School argues that Chinese corporate-governance laws are better than people think. They call for independent directors, separate the chairman's role from that of the chief executive, and grant shareholders many rights.

The problem with many of the firms whose accounts are currently under scrutiny is that they were registered in such places as the Cayman Islands, outside the reach of Chinese law. And the loophole that allowed them to list in America via reverse takeovers is an American loophole, not a Chinese one.

China's biggest corporate-governance problem is not its laws, but its government's willingness to enforce them even-handedly. William McGovern of Kobre & Kim, a lawyer and former SEC enforcement official, argues that aggressive action by American regulators after the Enron debacle restored confidence to American markets. China risks a similar crisis of confidence now, but Mr McGovern observes that its regulators have yet to act decisively at home or to co-operate with foreign agencies such as the SEC. Not all Chinese firms are crooked—but until China gets serious about regulating its companies, investors should remain wary.